Why don’t entrepreneurs diversify for retirement?
Apart from optimism, confidence and risk tolerance, the main reason entrepreneurs keep reinvesting in their businesses as opposed to building up a separate investment portfolio, is that they believe that the return on capital from the business is greater than the return on other investments.
The concept of retirement is also almost alien to entrepreneurs because they enjoy what they do and live for the challenge that only the business provides.
Business owners can also be motivated to keep reinvesting all spare funds in their businesses to lower their tax liability. For example, when income is invested in physical assets, such as equipment, the purchase of that equipment can be written off as a depreciation expense.
Why is your business not the sure thing?
The risk of relying on your business as retirement capital is that you can never be sure you’ll sell it. Research indicates that only 20% to 25% of privately owned businesses ever get sold. Often the value of the business is linked to the owner’s skills and personal relationships with customers. Having family members in top management positions also diminishes the prospect of selling.
What’s more, as markets and methods change many businesses become less and less relevant. Unless you’re an early adopter throughout your career, your business may no longer be at the cutting edge when you wish to retire. Not to mention factors beyond your control, such as increasing interest rates, aggressive competitors and disruptive technologies.
It’s important to accept that although you may feel invincible when you’re young and your business is thriving, you will age and slow down…Which could very well result in diminishing revenues and reduced business value.
If you accept the possibility that you may not be able to sell your business, it’s far easier to commit to investing in unrelated assets for retirement. A well-diversified portfolio can include your business, home, retirement funds (such as RAs or pension funds) and other investments such as unit trusts and shares. Diversification is a fundamental risk management technique which entails investing your capital across many different asset classes, geographical regions and industry sectors to spread your risk exposure. As a privately-owned business is a risky asset, it’s good to invest relatively conservatively outside your business.
Another benefit of diversifying from your business is that it allows you to make the most of a few irresistible tax breaks. A maximum of 27.5% of your remuneration or taxable income (whichever is higher), and no more than R350,000, is tax deductible in each tax year. There is no tax on the growth of assets within retirement funds, which accelerates their growth. Think of investing in retirement funds such as pensions, RAs and tax-free savings accounts as locking in the profits of your business.
Increase the chance of selling
Once you’ve accepted that it’s very risky to rely on the sale of your business for retirement, there’s still plenty of reason to work hard at increasing its saleability at every stage of its development. One of the best ways of doing this is to employ a skilled marketing professional and create a brand that represents more than just you, the owner. Try to build a brand that’s contemporary and embraces ongoing change, especially in the use of technology.
It’s also wise to invest in business assets that can be sold separately. Your business premises could be a valuable asset – if you’re not overly exposed to property in the rest of your wealth portfolio, that is.
Diversification within your business also lowers the risk of failure and will increase the likelihood of being able to sell it. This includes a diversity of clients, sources of revenue and funding. It’s also wise to cede some control and ownership to external stakeholders who bring the benefits of new ideas and business experience.
The bottom line
Business owners’ greatest strengths are often also their greatest weaknesses. Resolve, willingness to bear risk and persistent pursuit of success may be desirable traits for building a business, but they aren’t necessarily suited to sound retirement planning. Although diversification will slow down the growth of your business, it will also help to ensure that you have enough capital when you do retire.
Are you an entrepreneur or business owner? Speak to us about how best to structure your retirement plans. The sooner you get started, the better.
Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.